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Peter Schiff - Is Sovereign Debt Crisis Contained to Subprime?

17

As Americans observe the chaos in Greece, most assume that the strength of our currency, the credit worthiness of our government, and the vast expanse of two oceans, will prevent a similar scene from playing out in our streets. I believe these protections to be illusory.

Once again the vast majority fails to see a crisis in the making, even as it stares at them from close range. Just as market observers in 2007 told us that the credit crisis would be confined to the subprime mortgage market, current analysts tell us that sovereign debt problems are confined to Greece, Spain, Portugal, and perhaps Italy. They were wrong then, and I believe that they're wrong now.

Greece has finally asked for its bailout. But the sovereign debt question for Europe is bigger than Greece, as my column this week discusses.

There is no doubt that the debt-to-GDP numbers are high, but the euro-zone countries are rich and government revenues are generally high as a percentage of GDP, so their debt servicing bills are often affordable. Poorer countries that are less efficient taxers of their populations can sustain smaller burdens. On that basis, the rich countries of Europe, or most of them, should be able to sustain their high debts–though they may in some cases suggest years of sub-par growth.

As I was researching the numbers, one of the comparisons that stood out was that between the U.K. and France. In debt to GDP terms, forecasts suggest both governments will be carrying debts in a few years of 100% of debt to GDP. This is interesting because discussions in continental Europe about the euro-zone’s sovereign debt problems usually lead to finger-pointing across the Channel, and the suggestion that the UK’s debt problems are even worse than the euro-zone’s.

So here’s a brief look at some aspects of the UK’s debt vulnerability compared with that of France, using a useful table in an IMF report issued this week. (The link is below).

It shows the rating agencies agree with the continental finger-pointers. France’s top triple-A rating is stable; while the UK’s has a negative outlook. That’s even though the UK’s deficit at the end of this year will be below France’s, at 78% of GDP compared with 84%.

By some measures, France is more vulnerable. Foreigners tend to be more skittish than domestic bond holders and foreigners hold only 22% of British debt, compared with 58% of France’s. On top of that, a fifth of France’s debt is maturing in the next year, compared with 8.4% of UK government debt.

Why then would the UK be lower rated? The main reason is clearly the higher British budget deficit, which means the UK is piling on new debt faster than that of France. In 2010, the IMF says the UK’s structural budget deficit– i.e. adjusted for swings in the business cycle– puts it in the peloton of countries behind the race leader Greece at 7.6% of GDP this year. France is well back with a structural deficit of 4.6%.

One thing the British may have going for them is that they have an independent monetary policy and that sterling depreciation may help it kick-start growth faster than in the euro zone (though Greece’s problems are bringing about a depreciation of the euro that is the stuff of German exporters’ dreams.)

Nonetheless, relying on growth to reduce a debt burden may be an over-optimistic strategy in the British case. Most economists agree therefore that Britain must get its deficit down–though some argue the cuts shouldn’t start immediately–and that the most effective way to do that is to cut government spending.

The debt and the deficit have been important so far in the UK general election campaign and have come up repeatedly during the two television debates so far. But it’s not clear that, since the Conservatives lost popular support last year after attempting honesty about tough times ahead, any of the parties in the campaign have really come clean about how deep the spending cuts must be to get the debt on a downward trajectory.

(For people who like to look at source material, a host of new figures came out in the last week on sovereign debt, some of which were used in the column. The euro zone economic forecast from Ernst&Young is here. [Click on the table and you can get the country forecasts, including debt-to-GDP ratios, in more detail on the top right.] Eurostat’s new data, which included the Greek revision, is here. The IMF’s Global Financial Stability Report is here. The vulnerability indicators table is on page 5. Uri Dadush’s advice for Italy is in this article.)